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A moral compass for VC firms is non-negotiable

Criticism of the VC sector, however, is not meant to undermine its ability to propel innovation.

Venture capitalism isn’t a new idea. But it’s only in the last three decades that its effectiveness has come into sharp focus. The most innovative technology platforms and products of recent times have often been funded by venture-capital (VC) firms. The rise of VCs has been so profound that some argue that they’re the new central planners. However, unlike governments, VC firms don’t operate in public interest or have to report to anyone except their own shareholders and investors. There have been some spectacular lapses and it is high time the sector was reformed.

The VC sector’s effectiveness is a function of its nimbleness in working across borders, sectors and old-fashioned notions of investment protocols. There is a threat of reforming the VC sector to its death — even if you come up with a plan. The answer lies in harnessing the complex calculus of risk-taking and financial gains, married to a moral focus, that is found in sovereign wealth funds.

But first, the problems. An article in the New Yorker magazine goes through the spectacular rise and decline of the office co-working-space company, WeWork, to highlight the challenges surrounding venture capitalism. Because they often work in the shadows, VC firms have largely evaded public backlash for enabling reckless behaviour. The article begins by quoting the CEO of a WeWork competitor that was put out of business because of seemingly unlimited venture capital flowing to his rival. “VCs seem like these quiet, boring guys who are good at math, encourage you to dream big and have private planes. You know who else is quiet, good at math and has private planes? Drug cartels.”

Despite the buccaneering behaviour of the company, VC firms kept pouring money into it. Major VC backers stayed quiet while the company engaged in questionable business strategies. Why did these enablers escape scrutiny? Because VC firms and technology companies have written their own rules.

Criticism of the VC sector, however, is not meant to undermine its ability to propel innovation. A number of governments around the world have sovereign wealth funds that function like VC firms, like Temasek Holdings in Singapore and Mubadala in Abu Dhabi. Like VC firms, these funds make strategic investments in emerging sectors and participate in board-level decisions. Their aim is to get in on the ground floor of emerging technological developments.

But unlike VC firms, many sovereign-wealth investments are predicated on building new industries back home, creating new jobs for their citizens. In this, sovereign wealth funds have a greater — and moral — interest in ensuring their money is safely invested in companies that won’t implode. Greater participation of sovereign wealth funds in venture capital funding will, therefore, function to encourage partner investors, like the VC firms, to change their modus operandi.

Sovereign investment funds also have stakes in VC firms. For example, Saudi Arabia’s Public Investment Fund has a stake in SoftBank’s Vision Fund. As does Mubadala from Abu Dhabi. Malaysia’s Khazanah Holdings was reported to have been in talks over an injection of funds into the Vision Fund last year. An entrenchment of sovereign wealth fund participation in VC firms can change the character of such firms.

It’s worth noting that aside from the debacle at WeWork, SoftBank did make a very tidy profit off the initial public offering of DoorDash earlier in December. Meanwhile, Sequoia Capital, one of the largest VC firms in Silicon Valley, is poised for an 11-fold return this year.

The caveat, however, is that the technology sector operates by its own rules, and it might prove difficult to break its habit. Still, with their interests backed up by deep pockets, sovereign wealth funds have a chance at breaking norms at both tech and VC firms. It’s time to see forward-thinking nations start their own form of “disruption”.

Dana is editor-in-chief of emerge85

— Syndication Bureau